Real Income convergence Across states - Assignment Example

Sur Lecturer Real Income convergence Across s Introduction This paper provides a regression analysis that up s what Barro and Sala-i-Martin found out in their study “income convergence across states”. We acknowledged that their study found that states nominal income per capita was a converging series. However, one of the drawback in their research was that they used nominal income per capita, instead of series adjusted for inflation. Moreover, they did not put into consideration the disparity in the cost of living across states. Focusing on the main agenda as to whether poor countries or places experience faster than rich countries or places, analysis of Barro and Sala-i-Martin begun by looking at the predictions of the theories, relevance to a closed economy that uses the standard neoclassical growth model. The countries or states with poor economies experience increased levels on returns as compared to the rich economy states, a fact attributable to the diminishing returns to capital. Analyzing the neoclassical model on an international platform, it becomes noticeable that the effect of convergence is strengthened by both technological and capital outflow from rich economies to poor and, outflow of labor to rich economies from the poor ones. Hypothesis In ascertain whether real personal disposable incomes were converging to a certain constant value, we formulated our null hypothesis such that: Ho: there is income convergence across states (unit root exists for income series) H1: There is no income convergence across states (no unit root for income series and thus it`s stationary) LITERATURE REVIEW Previous empirical analysis focused on the increase of per capita income and the production level of the U.S. states (Shekhar, 115). Extensive studies have been undertaken on the analysis of the data regarding the personal income from the 1840s and on the cumulative produce of the state dating back from 1963. For analyzing purposes on what determines the growth of the states’ economy, the familiarity with the U.S. states acts as representation of resources that are not properly utilized: basically, there exists information on the 48 states for a period of more than a century. However, it seems obvious that the 48 states have an open economy. The findings regarding the presence of a convergence in the states become clear, with the logic that the poor economies tend to have a faster economic growth, contrary to what the rich economies have, in terms of per capita (Robert & Lieberman, 104). Nonetheless, reconciliation can be done on the convergence rates and the neoclassical growth model, for the closed economies. This aspect is true, on the condition that assumption is made on the values for the essential parameters of suitability and technology that depart significantly from obvious benchmark situations (Anupam, Philipson & Sun, 79). Above all, the model necessitates a high capital—share coefficient, in the brackets of 0.8. Subsequently, this enables the diminishing returns to capital to set root in a gradual manner as the state economy grows. A higher capital share coefficient can be realized if the features of an open economy is permitted. Such features are of significance for the states in the U.S. A comparison of the results have been done on the findings between the U.S. states and the cross—country sample. Lack of convergence is seen in the 98 countries in regards to the simple regressions of real per capita growth rate between the years of 1960 to 1985 (Mthuli & Ndou, 217). The countries that used to be rich during 1960, had the likeliness to have a faster growth in per capita terms as compared to the poor countries in such times. Additional descriptive variables such as opening values in the rates of student enrollments in school and mean ratio in the expenditure of the government to GDP should be increased. This notion arguably holds constant cross country dissimilarities in stability of state records in production per effective employee and the rate of increase in technology. In these prolonged regressions, the findings is that the approximated coefficients of convergence are the same to those publicized by the states in America. Even though there is proof of convergence, there is reconciliation with the model of neoclassical growth, which is in demand of increase in capital. The empirical findings elevates the citizens toward growth models that widely perceive capital to be inclusive of human capital, so that there can be a slow realization of the diminishing returns on revenue to act as a proof for the facts of convergence, there exist two models stand: the neoclassical growth model with a controlled obligation for decreasing returns and endogenous growth models, with returns to capital which do not vary. In the endogenous model, the impact on isolation of convergence would are explainable by the slow inflow of technology in the economies. At least in the last ten years, growth has occupied a key position among the benefits of macroeconomists, relocating to some degree their previous concern with the business activities. This change is mainly as a result of two reasons. Firstly, there is the understanding that, in accordance to the medium and lasting benefit, the tendency is more vital than the cycle – on the condition that the volatility of income continues to be as low as it has been in the previous years. Secondly, the other reason is the increasing lack of satisfaction with the old-fashioned neoclassical models that concluded the foregoing agreement on the contributing factors of growth, especially because of their apparent inability to have the responsibility for such significant features of the information as the witnessed increase in international disparity or the lack of capital inflow in the direction of the poor states. Convergence and divergence in growth theory As it is later learnt, the theory of convergence has a key role in the research work conducted (Bruce, 39). Although there will be a provision of a more clear-cut definition of this concept, provisional interpretation can describe convergence as short-hand for the probable presence of a tendency towards the fall in a period of time of differences in income through the countries or places. Thus, it can be said that convergence exists in a specific sample when the states with poor economies tend to have a faster growth than the sates with rich economies, subsequently lowering the difference in the income in the respective states. Bruce adds that when an opposite observation in pattern is made (that is, when there is a fast growth resulting into an increase in the gap of the lead) it is said that divergence exists in such a sample (108). Economic theory does give distinctive predictions regarding the amount of the convergence or divergence of per capita income in a state or region. Contrary, it does ascertain several factors or instruments that have the key capability of rising into either convergence or divergence. Hypothetical models based on various assumptions concerning the presence or relative prominence of such instruments can give rise to several different predictions regarding the progress of disparities of income disparities in the regional states. To some extent of over exemplification of risk, classification of growth models into two categories conferring to their predictions of convergence can come into place. According to those in the first category, it can be advantageous to have poor economies. Under such models, with other factors being held constant, the poor states tend to have a faster growth that the rich economies, relevance to the level of technology. This idea does not automatically imply the eventual eradication of inequality; as there can be inequality I other factors. Conversely, it does imply that the spread of relative income per capita in the regional states will lean towards the long run stabilization, given some significant "structural" features of the various economies become constant over time. In the second category of models, contrarily, the growth of economy is inversely related to the degree of inequality without any bound. The source of these dissimilar predictions have to be pursued in very elementary assumptions regarding the characteristics of the technology employed in production technology at a precise time and about the versatility of the progress of technology progress. The first mandatory condition for convergence is the presence of declining returns to level of capital (or, more normally, in the different forms of considered capital in the model). This assumption implies that production and the level of capital are less proportional. This means that the marginal production of this aspect will be lower together with its accrual, lowering both the need to save and the input to increase the level of investment and forming a reduction in the inclination for growth in a given period. Similar mechanism results into the foresight of convergence in the cross-section: counties with poor economies as a result of low capital base will have a faster rate of growth than the states with rich economies. This is as a result of the larger incentive to save and appreciate faster growth with an equal level of investment. This outcome will be strengthened by open-economy deliberations, as the movements of mobile factors, in addition to the international trade, will give rise to the equalization of characteristic prices and the rate of local production per employee. On a rather contradicting assumption (of capital returns that are increasing), the prior neoclassical idea is inverted and we get a divergence forecast. In this situation, the return on investment rises with the amount of capital per employee, preferring rich economies that have the tendency of a faster growth than poor economies, thus further creating wider gap of inequality. METHODS AND DATA From BEA and FRED web sites, we gathered annual real disposable personal income that are adjusted for inflation. The sample period was from 1980 to 2014. We developed an appropriate model of convergence and applied Augmented Dickey-Fuller unit root test to test our hypothesis. Data was set as a yearly series after which regression analysis was performed using STATA. The theoretical model to ascertain if states income per capita were indeed converging to constant value and that at one point in time the value will be equal across every state was such that: Δyt = α + γyt – 1 + εt…………………………………………..………………………………………………..……..(1) Where; Δyt represented yt - yt – 1 γ represented 1 – ρ εt represented White noise The series was tested for both 3 lags and 1 lag even though hypothesis testing under both lags yield similar results. RESULTS AND DISCUSSION From the data collected, we could see upward trend in real personal disposable income across states (see Figure 1). Generally, real income has been increasing with time. However, the Augmented Dickey-Fuller test revealed that the series was non-stationary. Table 1 and 2 gives a summary results at different lags. Table 1. ADF test, lag (3) Augmented Dickey-Fuller test lag (3) Number of obs = 32 Test statistics 1% critical value 5% critical value 10% critical value Z(t) -1.171 -3.702 -2.980 -2.622 MacKinnon approximate p-value for Z(t) 0.6860 Table 2. ADF. Lag (1) Augmented Dickey-Fuller test lag (1) Number of obs = 32 Test statistics 1% critical value 5% critical value 10% critical value Z(t) -2.732 -3.702 -2.980 -2.622 MacKinnon approximate p-value for Z(t) 0.0687 From our test results, the null hypothesis (Ho) is true. Usually, we only reject our null hypothesis when our calculated p-value is smaller than or even equal to the critical value as specified under different significance level, usually 1%, 5% and 10%. However, our approximate p-values are 0.6860 and 0.0687 in both cases, so we did not reject our null hypothesis under all the critical values. As such, we confirmed, using real income per capita, what Barro and Martin found in their study: states incomes were converging to a constant value that will at one point in time be equal across all states. These results confirms the first mandatory condition for convergence, which is the presence of declining returns to level of capital (or, more normally, in the different forms of considered capital in the model). This assumption implies that production and the level of capital are less proportional. This means that the marginal production of this aspect will be lower together with its accrual, lowering both the need to save and the input to increase the level of investment and forming a reduction in the inclination for growth in a given period. An assessment as to whether poor countries or places experience faster growth rate than rich ones is a crucial key. Also, in accordance to this, the other question to ask is: are there obvious external or internal influences that result into the convergence during sometime in the amounts of per capita income and outputs? It is only after bearing in mind the forecasts on the theories regarding the closed-economy and open-economy neoclassical growth, then data examination can be done on the states in the U.S since 1840. There is the realization of valid evidence of convergence, but there can be a quantitative reconciliation on the findings with the models of neoclassical on the condition that weakening incomes on revenue come to place gradually. The outcomes from a wide sampling of countries become the same if we a set of variables are held constant. The set of the variables are the proxy for variances and characteristics for the sates that are stable. Two of the prevailing theories appear to prove the facts: firstly, the neoclassical growth model with wide and well definite capital and a limited obligation for decreasing income. The second theory is of the endogenous growth models with steady returns and gradual technological flow in the economy of the states. At the empirical level, there exist viable literature that tries to examine the viability of the different models that have been anticipated, and to prove the effect of various preferential factors on growth and on the growth of global or interregional differences on income. This paper offers an outline to the theoretical and empirical literature regarding the growth and convergence in the regional states. The organization of the work is as follows: Section 2 discusses some overall concerns on the convergence and divergence instruments depicted in the growth literature. In Section 3, a simple illustrative model is given that tries to focus on the major immediate factors that influence growth of output and discusses how some crucial characteristics of technology govern the how the evolution of the global or interregional income are distributed. Economic theory pinpoints influences with divergent effects on the dynamics of capital. Convergence instruments appear highly in the neoclassical and catch-up models that greatly influenced the literature up to the recent times. The apparent failure of the promising convergence forecasts of these models, however, has inspired the exploration for options and contributed to the coming up of new theories that combine numerous divergence factors. Part of the developers of the "endogenous growth" theory concentrated on the chances of increasing returns to only factor in capital, whereas other authors, like Irvin (63) established models where the degree of technical progress was endogenously influenced and could be differently permanent in all the states, showing changes in structural features. In all the cases, the theory permits the chance of a continual increase in the amount of global or interregional disparity. CONCLUSION To conclude, this paper provided the regression analysis which updated the findings of Barro and Sala-i-Martin with regard to their study “income convergence across states”. We relied on the reality that their study had revealed that states nominal income per capita was a converging series. But then again, our research was anchored on the reality that Barro and Sala-i-Martin used nominal income per capita, instead of series adjusted for inflation. Work Cited Aiyar, Shekhar. Growth Slowdowns and the Middle-Income Trap. Washington, D.C: International Monetary Fund, 2013. Computer file. Barro, Robert J, and Xavier Sala-i-Martin. Convergence Across States and Regions. New Haven, Conn: Economic Growth Center, Yale University, 1991. Print. Dinçer, Hasan, and Ümit Hacioğlu. Global Strategies in Banking and Finance. , 2014. Internet resource. Gangopadhyay, Partha. Economics of Globalisation. Aldershot [u.a.: Ashgate, 2005. Print. Hall, Robert E, and Marc Lieberman. Economics: Principles & Applications. Australia: South Western Cengage Learning, 2013. Print. Hyclak, Thomas, Geraint Johnes, and Robert J. Thornton. Fundamentals of Labor Economics. Mason, Ohio: South-Western Cengage Learning, 2013. Print. Jena, Anupam B, Tomas J. Philipson, and Eric Sun. Health and Wealth Disparities in the United States. Washington, D.C: AEI Press, 2010. Print. Ncube, Mthuli, and Eliphas Ndou. Monetary Policy and the Economy in South Africa. , 2013. Internet resource. Publishing, OECD. National Accounts of Oecd Countries, Volume 2011 Issue 1: Main Aggregates. Paris: Organisation for Economic Co-operation and Development, 2011. Internet resource. Scott, Bruce R. Capitalism: Its Origins and Evolution As a System of Governance. New York: Springer, 2011. Internet resource. Tucker, Irvin B. Macroeconomics for Today. , 2014. Print. Appendices Figure 1. Test results: lag(1) Figure 2. Test results; lags(3) Figure 3. Test results: lag(1) trend regress Figure 4. Test results: lag (3) trend regress do.file dfuller yt1, lags(3) dfuller yt, lags(3) dfuller yt1, lags(1) trend regress dfuller yt , lags(3) trend regress Read More